18 May 2016

Sky TV shares surge, Spark falls on Vodafone merger

Sky Network Television [NZX: SKT] shares have surged while Spark New Zealand [NZX: SPK] fell on speculation a Sky TV-Vodafone Group merger will provoke even more intense competition in broadcast content and the platforms it is delivered on.

Sky TV stock jumped 17 percent to a month-high $5.25, still below the $5.40 price at which Vodafone would be issued shares in the combined company. Spark fell 3.6 percent to $3.36, the lowest since late February. Under the transaction unveiled today, Sky TV would acquire all the shares in Vodafone New Zealand for $3.44 billion in shares and cash, giving Vodafone 51 percent of the merged group - in effect a reverse takeover.

The merger would allow Sky TV and Vodafone to strip out costs while continuing to offer bundled content and broadband packages against offerings from Spark and its Lightbox service. The deal still requires Commerce Commission, Overseas Investment Office, and shareholder approvals. The reality for both groups is that they've been contending with relatively low growth, with Sky TV experiencing a "plateauing out" of demand, while Spark's shares have been underpinned by capital returns and dividend yield, said Paul Richardson, chief investment officer at Mint Asset Management.

"This will become a quite a lot more competitive sector, battling for the hearts and minds of consumers," Richardson said. "The whole sector isn't priced at a premium anymore. Multiples paid in deals have been at a discount to the general market here, in Australia, and the rest of the world. How much more mobile growth can you get? How much more margin can you get out of media?"

Sky TV and Vodafone say the merged company would generate cost and capital expenditure savings of about $415 million, or 52 cents per share, after integration costs, as they rationalise overlapping functions and use Vodafone NZ's technical and network capabilities to improve the efficiency of sales and marketing. They also expect to have access to lower cost set-top boxes through the larger Vodafone Group and may reduce the amount of satellite transponder capacity required as they step up delivery of content through the internet.

"The merger brings together Sky's leading sports and entertainment content with our extensive mobile and fixed networks, enabling customers to enjoy their favourite shows or follow their team wherever they are," said Vodafone's local head Russell Stanners, who would lead the enlarged company while Sky TV chief executive John Fellet would report to him as head of media and content. "The combination with Sky will bring greater choice, enhanced viewing experiences and will better serve New Zealanders as demand for packaged television, internet and telecoms services increases."

Mint's Richardson, though, said projected synergies have to be taken with a grain of salt and it is too early to judge how it will play out, especially as younger consumers increasingly use social media such as Facebook to access content. Spark "clearly faces a bigger competitor" and will need to ramp up spending to ensure Lightbox is a serious contender.

"Maybe we're seeing old-time media sectors having to merge," he said. "Maybe neither of these two big groups have the offerings that the new generation wants."

Spark New Zealand Managing Director Simon Moutter said his company already "competes hard" with Vodafone but doesn't see itself going head-to-head with Sky TV. "The real competition in the future of media is with global over-the-top players like Netflix, YouTube and Apple or with direct-to-consumer premium sports content owners," Moutter said in a statement.

Sky TV plans to borrow $1.8 billion from Vodafone to fund the purchase, repay its existing debt and fund the working capital needs of the group after the merger. The deal already has the unanimous backing of Sky TV's directors ahead of a shareholder vote expected in early July, where at least 75 percent of votes cast are needed. Independent adviser Grant Samuel said in its appraisal that Sky TV shareholders "will clearly be better off if the proposed transaction proceeds than if Sky TV continues as a standalone entity" and that "the price and terms of the share issue are fair".

Analysts at UBS say the most obvious potential benefits of the merger are from customer retention and new formats such as internet TV.

"At this early stage we believe the most likely sources of value creation are lower telecom customer churn and stronger internet TV penetration," the analysts said in a report. "We believe the combined group would be looking at international trends of bundling differentiated online content with traditional mobile and broadband services as a way of holding onto and winning customers without impacting prices."

Still, "the key challenge is the potential cannibalisation/spin-down of SKT's existing pay-TV customer base," they said. A competitive response from Spark was likely to include more aggressive competition for digital rights to high-rating sports content. Regulatory risks included the possibility of anti-siphoning requirements such as in Australia and the UK, they said.

The merger comes after Vodafone put its New Zealand business up for sale, with other parties having been through its data room before the Sky TV deal was hatched.

Moutter painted a picture of a rival group in decline, saying: "Sky TV's core subscriber base has declined while Vodafone NZ's broadband base has had little or no growth since they acquired Telstra Clear nearly four years ago. As such, we don't believe a merged Sky TV and Vodafone NZ poses a greater challenge to Spark than the existing partnership has achieved to date."

But Spark itself faces challenges. "Looking at it from 30,000 feet, we're not seeing a lot of growth from Spark either, and they're rewarding shareholders by returning capital. It's a low-growth sector," Mint's Richardson said.